Why Barack Obama Compromised On Tax Cuts

Long before the midterm ballots had been counted, White House aides had begun to mull the coming agony of divided government. As the Obama team worked out its options, one priority kept coming to the top: However, the next two years shook out, they told themselves, Barack Obama needed to convince the great middle of the American electorate once again that he was fighting for them.

On Monday night, just in time for most nightly news casts, Barack Obama stood behind a podium to announce his first major gambit in this new quest, a costly compromise “framework” on tax cuts that gave Republicans a major prize, Democrats several minor prizes, and a chance for the president to position himself as a man above the Washington fray, doing what needs to be done for the American people. “I’m not willing to let working families become collateral damage,” Obama said. “The American people didn’t send us here to fight symbolic battles or win symbolic victories.”

The president presented a series of major concessions to the Republican Party, proposals he had campaigned against and with which he said he still disagreed. For two years, expiring income tax cuts put into place by President Bush would be extended for all income groups, including the richest two percent of households. A cut on the estate tax would also be extended, in a modified form, with no taxes on the first $5 million of inheritance and a 35% tax on everything else.

In exchange, Obama said he had secured an extension of unemployment benefits for 13 months and a number of tax cuts, for education expenses, families with children and the low income from the 2009 Recovery Act that were set to expire. One of those tax cuts, which had long been criticized by Republicans, the Making Work Pay Tax Credit, would be traded for a similarly generous 2 percent decrease in the payroll tax for workers. There was also a deal to extend certain business incentives.

A cynic could read the deal, which still needs to be accepted by rank and file members of Congress, as a classic Washington giveaway. In order to gain acceptance for budget-busting benefits that Republicans wanted, Obama had negotiated budget-busting benefits that Democrats wanted. The White House offered no estimates for the costs of the two-year deal Monday night, but it is likely to cost as much as $200 or $300 billion$900 billion (it’s hard to know without a proper score of the proposal), money that will simply be borrowed with expectation that another generation can foot the bill.

But at the White House, where there is much anxiety about the staggering performance of the economy, this is considered a victory. In crafting the compromise, Obama may be able to effectively sneak another stimulus bill through Congress, by capitalizing on the Republican habit of refusing to acknowledge the deficit impact of tax cuts.

Moody’s economist Mark Zandi, who advises both political parties, estimates that every dollar of federal spending on unemployment benefits would give a $1.60 jolt to the economy. Every dollar spent on a payroll tax holiday would give a $1.24 jolt. And every dollar spent on extending the Bush tax cuts would result in a much smaller, 34 cent jolt to the economy, in part because much of that money is likely to be saved. “In the current environment, emergency unemployment insurance is much more efficacious that tax cuts for upper income groups,” said Zandi, in an email to TIME. “Given the fragility of the recovery, however, I would do both.”

Privately, Obama aides still smart at the cost of giving roughly $60 billion a year for two years to the nation’s richest households. The president’s economic advisors have estimated that the multiplier effect for tax cuts to those making more than $250,000 a year is probably between ten and twenty cents on the dollar, or about nine times less effective than unemployment benefits.

But in the current environment, this may have been the only way that Obama could fire another fiscal jolt into the economy. Zandi’s estimated that if both the expiring tax cuts and the unemployment insurance program expired in 2011, the hit to the economy would approach $375 billion, or 2.5% of GDP, a number large enough to wipe out any real gains and likely return the country to recession.

In his address, Obama made it clear that he hopes to fight these battles again in his reelection, when the tax cuts again expire in two years. “I’m confident that as we make tough choices about bringing our deficit down, as I engage in a conversation with the American people about the hard choices we’re going to have to make to secure our future, and our children’s future, and our grandchildren’s future, it will become apparent that we cannot afford to extend those tax cuts any longer,” Obama said.

But for that to happen, he will need an economy that is growing faster than it is today. And he will need to have regained the trust of a majority of American voters. This first compromise, he and his aides hope, is a start in that direction.